Cyprus lawmakers reject bank tax; bailout in disarray

NICOSIA (Reuters) - Cyprus overwhelmingly rejected a proposed levy on bank deposits as a condition for a European bailout on Tuesday, throwing international efforts to rescue the latest casualty of the euro zone debt crisis into disarray.

The vote in the tiny legislature was a stunning setback for the 17-nation currency bloc, angering European partners and raising fears the crisis could spread; lawmakers in Greece, Portugal, Ireland, Spain and Italy have all accepted austerity measures over the last three years to secure European aid.

With hundreds of demonstrators outside the parliament chanting “They’re drinking our blood”, the ruling party abstained and 36 other lawmakers voted unanimously to reject the bill, bringing the Mediterranean island, one of the smallest European states, to the brink of financial meltdown.

Finance Minister Michael Sarris had already headed to Moscow, amid speculation Russia could offer assistance given the high level of Russian deposits in Cypriot banks. President Nicos Anastasiades, barely a month in office, spoke by phone with Russian President Vladimir Putin after the vote.

Anastasiades was due to meet party leaders at 9 a.m. (0700 GMT) on Wednesday to explore a way forward.

“The voice of the people was heard,” 65-year-old pensioner Andreas Miltiadou said among a crowd of demonstrators jubilant after the vote.

EU countries had warned they would withhold 10 billion euros ($13 billion) in bailout loans unless depositors in Cyprus, including small savers, shared the cost of the rescue, an unprecedented step in the stubborn debt crisis.

The European Central Bank had threatened to end emergency lending assistance for teetering Cypriot banks, which were hard hit by the financial crisis in neighboring Greece.

The island’s partners barely disguised their anger.

Euro zone paymaster Germany, facing an election this year and increasingly frustrated with the mounting cost of bailing out its southern partners, said Cyprus had no one to blame but itself for the gravity of the situation.

DEBTS TOO HIGH

“Cyprus requested an aid program,” German Finance Minister Wolfgang Schaeuble told ZDF television. “For an aid program we need a calculable way for Cyprus to be able to return to the financial markets. For that, Cyprus’s debts are too high.”

Dutch Finance Minister Jeroen Dijsselbloem, who chairs the Eurogroup of finance ministers, said the bailout offer still stood providing the conditions were met. European Central Bank Governing Council member Ewald Nowotny called on Cyprus to show “discipline and the readiness to act rationally.”

But it was Europe’s demand at the weekend that Cyprus break with previous EU practice and impose a levy on bank accounts that led outraged Cypriots to empty bank cash machines and unsettled financial markets.

An important issue in negotiations has been the high level of deposits held in the island’s banks by non-EU citizens and companies, notably from Russia, where Cyprus has established itself as a major provider of offshore financial services.

BACKLASH

The EU and International Monetary Fund are demanding Cyprus raise 5.8 billion euros from bank depositors to secure the bailout it needs to rescue its financial sector. They say a bailout of more than 10 billion euros would tip Cyprus’s debt level into unmanageable territory for its 1.1 million people.

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But lawmakers said the levy on deposits crossed a red line.

“You can’t take a 10,000-metre jump without a parachute. And that’s what they’re asking of us,” said George Perdikis of the Greens Party.

International market reaction has been muted so far but that might change.

While Brussels has emphasized that the measure was a one-off for a country that accounts for just 0.2 percent of European output, fears have grown that savers in other, larger European countries might be spurred to withdraw funds.

Dijsselbloem, the Eurogroup chair, said there would be no need to impose a levy in any of the 16 other euro countries.

Some Cypriots hope they can get aid from Russia, which has bailed out Cyprus in the past. Many Russians keep their money in Cyprus and operate businesses from there.

Russian authorities have denied that the Kremlin might offer more money, possibly in return for a future stake in Cyprus’s large but as yet undeveloped offshore gas reserves, which have raised the island’s strategic importance.

An influx of Russian money and influence since the collapse of the Soviet Union has led some Brussels officials to complain privately that Cyprus acts at times as a “Trojan donkey” for Moscow inside the European Union since it joined in 2004.

Banks in Cyprus are to remain shut on Wednesday to avoid a bank run. The island’s stock exchange will also be closed on Wednesday. ($1 = 0.7760 euros)